1- Dollar a high-yielder soon: "A striking pattern of
previous Fed hiking cycles is that the dollar has weakened following the
first FOMC rate increase. The most likely reason is that US yields have
ranked in the bottom-3 or below at the start of all major Fed hiking
cycles since the 1980s. Low-yielding status is historically associated
with significant dollar depreciation, even as rate differentials have
widened in favour of the USD as the rate cycle unfolded. This Fed cycle
is unique because the dollar is already and remarkably a mid-yielder
compared to the rest of the world: US short-end rates are currently
higher than half of G10 FX, and assuming current forwards are realized
(2 Fed hikes this year) the USD will become a full-fledged high-yielder
by the end of the year. A highyielding dollar leads to significant
dollar outperformance based on past experience, making the ranking of US
yields an important dollar supportive factor in 2016 (chart 1)," DB
argues.
2- Risks skewed toward better US data. "Another unique
part of the current Fed hiking cycle is that it has started at a time of
disappointing US data releases. The last year has seen the longest run
of uninterrupted negative US data surprises going all the way back to
the early 2000s (chart 2). Similarly, the number of economists expecting
3%+ growth this year has dropped to a new post-crisis low according to
the Philly Fed survey of professional forecasters. The odds are
therefore skewed the other way. Even if it will only take two Fed hikes
to make the dollar a high-yielder, there are upside risks to both growth
expectations and the number of Fed hikes that are priced in," DB adds.
3- Portfolio flow unique as well. "Typical dollar bull
runs have been accompanied by a significant rise in foreign US inflows.
But there is something unique about the current portfolio cycle as well.
The USD is currently benefitting from large repatriation of assets by
American investors, whose selling of foreign securities is running at an
all time high. This is driving the US private basic balance to the
highest levels in almost two decades, which is suggesting that the US
TWI is in-line with portfolio flow trends. The dollar's reliance on
repatriation makes American portfolio preferences the most important
factor behind the current dollar up-cycle. It is the dearth of
investment opportunities abroad rather than renewed foreign interest
that is driving dolar strength," DB notes.
4- Europeans abandoning Europe. "On the other side of
the Atlantic the recovery remains intact but the euro has not been
responsive to better European data. Ongoing ECB dovishness, negative
yields, and European investors' large underweight in foreign assets all
suggest that these outflows are likely to continue, a phenomenon we have
previously termed Euroglut. Interestingly, the composition of portfolio
flows between different investors has undergone a significant
transformation over 2015. Non-bank portfolio flows have become the
dominant portion of Euro-area capital outflows, suggestive of underlying
shifts in European investor preferences rather than changes to bank
balance sheets that are also typically hedged (chart 4)," DB adds.
5- ECB taper not important as Fed rate hikes. "Persistent
weakness in the oil price and downside surprises to inflation suggest
that the risks are skewed toward more ECB easing this year. But could a
decision by the ECB to taper its QE purchases later mark the end of the
EUR/USD bear run and by extension the long-term dollar up-cycle? It is
doubtful this would be the case because ECB decisions on QE are more
relevant for the long-end of the European curve rather than near-term
rate expectations. The latter in turn exert significantly higher
influence on FX (chart 5). So long as the European short-end remains
anchored, it will be the pace and timing of the Fed cycle that will
dominate dollar drivers rather than the pace of ECB QE," DB argues.
6- China and risks to dollar outlook. "The biggest risk
to our dollar view is a significant slowdown in the US economy that
stops (rather than decelerates) the Fed hiking cycle and potentially
brings easing back on the table. Beyond that, portfolio flows, relative
central bank cycles, and China's recent willingness to tolerate more
dollar strength all suggest the dollar has more scope to appreciate in
2016. The latter is particularly important because past USDCNY stability
has prevented the broad trade-weighted dollar from appreciating as much
as the narrow index given China's high weighting. Given our ongoing
bearishness on RMB (see theme 7) we therefore prefer the broad over the
narrow trade-weighted dollar, which also remains cheaper on account of
CNY valuations. Indeed, even if the current dollar rally is faster than
the late 1990s, it remains well within the bounds of previous dollar
cycles," DB adds.
